Why Iran matters to oil markets

Tehran is ensnared in a growing dispute with the West. Traders are nervous it might pull its oil off the market.

NEW YORK (CNNMoney.com) -- As tensions mount with Iran, oil markets around the world remain fixated on the Persian Gulf, ready to send prices soaring on the slightest hint of escalation.

Exhibit A was Tuesday when crude oil jumped $5 a barrel, or about 8 percent, on rumors, later denied, that U.S. warships had clashed with Iran's naval vessels.

But the United States gets less than 20 percent of its oil from the Mideast, and has an embargo on all oil from Iran. Plus, experts say Iran needs to export oil just as badly as the world needs to buy it, making a complete shutoff unlikely.

So why do events in the Gulf have such an impact on U.S. oil and gasoline prices?

Because oil is traded on the world market, experts say the longstanding U.S. embargo is basically meaningless as far as prices go. Iranian oil exports, most of which are shipped to Japan, simply alleviate the need for the Japanese to buy that oil elsewhere. Oil traders know this, and set the price of oil accordingly.

But with worldwide demand for oil running high, and supplies barely able to keep up, a disruption of Iranian exports has traders nervous.

Iran, the world's No. 4 producer, has been playing hardball of late. It seized 15 British sailors Friday, accusing them of trespassing in its territorial waters.

It remains defiant in the face of recently tightened United Nations sanctions designed to stop the country from enriching uranium. Iranian President Mahmoud Ahmadinejad refused to even come to New York for the U.N. vote, saying the United States took too long to issue the visas.

And after rumors circulated Tuesday that Iran fired on U.S. warships in the Gulf, crude prices surged briefly, spiking by $5 to just over $68 a barrel, though they later retreated. Crude closed at $64.08 in New York Wednesday. And although the U.S. denies the incident, speculation remains that it happened.

Traders fear military action could disrupt oil supplies flowing through the narrow Strait of Hormuz, which Iran borders on the north.

And although Iran relies on oil exports for up to half its government budget, traders fear the country could use oil as a weapon, withholding it in retaliation for sanctions or a military strike on its nuclear program.

"If you want to see a quick way for oil spices to spike to $100, all they have to do is threaten to pull some or all of their oil off the market," said Neal Dingmann, a senior energy analyst at Dahlman Rose & Co., a New York-based energy investment firm.

Iran pumped about 4 million barrels of oil a day in 2006, according to the U.S. Energy Information Administration. With worldwide production at about 84 million barrels daily, Iran ranks as the world's fourth-largest producer behind Russia, Saudi Arabia and the United States.

Iran exported about 2.6 million barrels a day in 2005, according to EIA, making it the world's fourth largest exporter as well.

With an estimated 137 billion barrels, the country's oil reserves are second only to Saudi Arabia's 264 billion barrels, according to EIA. And it has the world's second-largest reserves of natural gas, behind Russia.